Central bankers generally set policy based on their judgment about the most likely path for the nation’s economy. But Mr. Greenspan argued that the Fed sometimes should do more than its forecast suggested, buttressing the economy against large, potential risks. He described such moves as “taking out insurance.” On the eve of the Fed’s policy-making committee meeting on Tuesday and Wednesday, members who favor additional action argued that the likely path of the economy was itself sufficient reason for action. The committee predicted in June that without new measures unemployment would fall slightly, if at all, in the second half of the year.
But officials, including the Fed’s vice chairwoman, Janet L. Yellen, have sought to reinforce the case for action by arguing that the Fed also should seek to offset the looming risk that a European turndown will set off a global financial crisis, or that a failure to dismantle the potential year-end fiscal cliff of government spending cuts and tax increases will tip the economy back into recession. “There are a number of significant downside risks to the economic outlook, and hence it may well be appropriate to insure against adverse shocks that could push the economy into territory where a self-reinforcing downward spiral of economic weakness would be difficult to arrest,” Ms. Yellen said in a June speech.
Laurence H. Meyer, a former Federal Reserve governor who, like Ms. Yellen, served under Mr. Greenspan, said that the return of “insurance” as a factor in the Fed’s decision-making was a necessary response to the current environment. “There are many people who look at that idea and feel that this is what was done under Greenspan, and maybe this was one of the factors that led to excessive speculation,” said Mr. Meyer, now senior managing director at Macroeconomic Advisers, an economic forecasting firm based in St. Louis. “But when the downside risks have grown as large as they have become, I think you have to consider it.”
Proponents of new action continue to face resistance from officials who remain uncertain that the economy has lost momentum and would prefer to wait at least until the FedÂ’s next meeting in September. Ms. Yellen herself is not among the officials who have said publicly that they are convinced the Fed should act now. The hesitation also reflects widespread concern about the waning potency of the FedÂ’s remaining tools, and about the cost of the most powerful measure, an expansion of its holdings of Treasuries and mortgage-backed securities. The Fed also is under significant but counterbalancing political pressure in the midst of a presidential election. Republicans oppose additional action, which they describe as ineffective and likely to increase inflation, while Democrats want the Fed to do more.
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